Legendary fund manager Li Lu (who backed Charlie Munger) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, ASOS Plc (LON:ASC) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
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What Is ASOS’s Net Debt?
As you can see below, ASOS had UK£475.9m of debt, at August 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has UK£323.0m in cash leading to net debt of about UK£152.9m.
How Strong Is ASOS’ Balance Sheet?
According to the last reported balance sheet, ASOS had liabilities of UK£1.04b due within 12 months, and liabilities of UK£942.0m due beyond 12 months. On the other hand, it had cash of UK£323.0m and UK£111.2m worth of receivables due within a year. So it has liabilities totaling UK£1.55b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the UK£663.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, ASOS would likely require a major re-capitalization if it had to pay its creditors today. When analyzing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ASOS can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, ASOS saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that’s not too bad, we’d prefer to see growth.
Over the last twelve months ASOS produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at UK£9.8m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through UK£303m in negative free cash flow over the last year. That means it’s on the risky side of things. The balance sheet is clearly the area to focus on when you are analyzing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 1 warning sign for ASOS that you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.